Explore fixed price vs. time & materials contracts and find the ideal match for your project type in this concise guide.
Typically, a new product development process involves contractors. This is especially relevant for startups and small businesses who lack the resources to hire engineers, industrial designers, technologists, and electronics developers, as well as to produce their own goods. The best course of action in this case is for them to acquire the necessary expertise from business process outsourcing companies.
The degree of understanding between the client and the contractor in this situation will determine how well the project turns out. It's of particular importance to forge a trustworthy basis for their communication to be productive. So, a contract and its related appendices will come in handy in this case and serve as a reliable base for business process outsourcing. In this article, our focus will be on examining the most widely used contract types and providing detailed insights into the Statement of Work (SoW).
Hopefully, after reading this article, you will gain a clear understanding of which type of contract will be the best suit for you while outsourcing services, as well as which Statement of Work (SoW) would be the optimal choice for your project.
Steps you should take before laying out a Statement of Work
Signing an NDA
NDA (Non-Disclosure Agreement) is a legally binding customer-supplier contract in which both parties agree not to share confidential information with a third party. Nondisclosure agreements serve as the cornerstone for the development of trustworthy relationships by protecting a customer from product concept or technology leaks.
Thus, the first step is signing an NDA. The quality assessment and project's success depend on our partners' composure and confidence from the start of our collaboration. By way of example, EnCata typically states that the client possesses full ownership of the intellectual property generated during new product development.
Making a Master Service Agreement (MSA)
MSA, or a general contract, outlines and governs how the parties will conduct their joint operation.
An MSA typically covers the following aspects:
- payment terms;
- intellectual property owner;
- marketing rights;
- limitations of liability;
- dispute resolution methods;
- warranties and indemnities;
- other general cooperation parameters.
Master Service Agreements act as the basis for cooperation between EnCata and its customers. They assist us in outlining the interaction mode with our partners.
Statement of Work (SoW)
The Statement of Work establishes the guidelines and controls the tasks performed within a particular project. To a specific degree, SoW serves as a supplement to Master Services Agreements, outlining the following elements pertaining to the project:
- delivery date;
- billing terms;
- terms and milestones for the execution of the project.
The composition of a Statement of Work can vary depending on the unique characteristics of each project and an outsourcing company, and there are no rigid guidelines dictating its specific format. In this article, we explore the most commonly employed types of Statements of Work within EnCata.
Fixed Price / Fixed Scope
- All project outcomes are thoroughly discussed and explicitly delineated.
- The project is set at a fixed cost.
- The SoW is designed to curb the number of changes.
- Fixed price/scope contracts offer assurance and clarity for both the client and the contractor.
- Given that there is less need to keep track of labor costs and material expenditures, this type of contract is easier to manage.
- A fixed price/scope contract is best for projects that are simple to implement, but as a project becomes more intricate and multi-layered, the risks increase and become harder, if not impossible, to account for in a fixed contract.
- High costs associated with intricate and lengthy projects. Which follows from the previous point. When there is a lot of uncertainty, risks must be factored into the cost of the project.
Time and Materials contracts (T&M)
- The project's objectives are determined by you and the contractor.
- The final product is determined by your business and the outsourcing company you delegate your project to.
- Contracting parties work to add value from sprint to sprint, rather than fixing every step of development.
- The subject of the contract revolves around the hours and materials utilized by the contractor during project development, rather than the end result itself.
- Total transparency. Both the customer and the service provider enter into a contract for the development process, such as 500 hours of designing an IoT device, rather than the finished product.
- There is a small risk for the contractor since Time and Materials guarantees that all development costs will be covered. Thus, you can expect a lower price from a contractor, compared to a fixed price contract.
- Flexibility. This type of contract does not set rigid boundaries and allows for changes to be made to the product development strategy, technical and functional requirements for the development object, which is especially useful in complicated and multi-level projects where there is a high likelihood that requirements and specifications will change during development.
- If T&M lowers risks for the contractor, then deadlines and a lack of a fixed pricing enhance risks for the customer. This scenario adversely impacts the contractor's competitiveness, as a contractor offering a fixed price and adhering to deadlines is more likely to succeed in the bidding process.
- The T&M contract implies ongoing monitoring of time and material costs, which diverts the contractor's focus away from resource management and could theoretically drive up project costs, especially if the project is not difficult.
Choosing a suitable contract type for your project
Each project has different requirements, challenges, and hazards. A perfectly composed PRD, clear-cut terms of reference and a defined scope of work do not ensure project success. If the aforementioned documents are worked out, plans are made, and choices for the event's development are discussed, errors will be less likely to occur. The manner in which the contractor and the customer interact, as governed by the Statement of Work, can boost the chances of a hardware project's success.
According to the Cynefin framework, there are four distinct types of projects, systems, and environments in which we think and act: those that are clear, complex, complicated, and chaotic. Table 1 demonstrates the action sequence for each type of contract.
As seen from Table 1, chaotic and complex models are the extremes, and settling on a contract type is not a difficulty.
Fixed price/scope contracts are highly advantageous for clear model projects, where risks for both the customer and contractor can be quantified and taken into account. The client specified the project's objective and expected results, and the contractor is aware of how to achieve it.
For chaotic projects, T&M is ideal as there is no established method to attain the desired results. The customer and the contractor progress iteratively through trial and error (development, testing, analysis, and development are the sprint’s objectives).
Time & Materials enables the acquisition of interim results in chaotic projects, allowing for the planning of subsequent steps, the modification of the device's functioning and design, the specification of anticipated outcomes, and the achievement of the project's objective. In this situation, everyone benefits. The customer can always change the product development approach or stop development if there is considerable uncertainty and hazards, and the contractor avoids the possibility of being penalized for failing to complete the project on time.
Let's move on to the two remaining systems. Complex projects are, in essence, a set of simple projects/models. The proper interaction of simple systems within a sizable ecosystem is where the majority of complexity and risk exist. A fixed price/scope contract appears to be the best option for both the customer and the contractor in such projects because outcomes and risks can typically be forecast. A crucial phase in this process will involve the creation of a detailed Statement of Work (SoW). We suggest putting this in a separate work phase, as crafting a comprehensive SoW of high quality often entails significant labor costs and necessitates the expertise of specialists external to your team. It makes sense to involve your contractor in this process since you can jointly create the agreement, see how it fits your needs, and share responsibilities.
Complex systems are defined by the need for significant innovation, which creates a highly dangerous environment at both the level of individual nodes and components development and the ecosystem as a whole. This is a long-term project with clear expected results and goals, but there are significant risks when integrating the project's various components into a cohesive ecosystem. Typically, in projects like these, there are numerous ambiguous aspects where it's challenging to gauge the amount of work involved until the project is initiated.
It is advantageous to employ a hybrid contract approach for complex projects, where certain portions of the work are carried out at a fixed price, such as the discovery phase, MVP development, prototyping, assembly, and testing. Meanwhile, other parts of the project that involve significant uncertainty are handled through a Time and Materials (T&M) basis, such as the development of unique electronic and firmware solutions.
The following table illustrates the most optimal types of contracts for each project type.
To crown it all, you must complete the following procedures when outsourcing hardware development:
- Master Service Agreements (MSA);
- Statement of Work (SoW)
It is crucial to choose the best interaction format within the SoW framework based on the particulars of your project. Fixed Price/Fixed Scope contracts are likely to be best for simple and complex projects, but Times & Materials or a combination of Times & Materials and Fixed Price/Fixed Scope contracts is preferable when dealing with complex and chaotic ones.